Famed Short-Seller Jim Chanos on Stock Investment Traps

Michelle Leder writes:

Last night, I spoke about the importance of reading filings — something I think anyone who buys individual stocks needs to do. But I was really just a warm-up act for Jim Chanos, who gave a great 28-page presentation about classic value investing traps. I don’t have access to a scanner here in my hotel room to provide the whole presentation, but I thought that his list of common value traps was worth sharing:

• Cyclical and/or overly dependent on one product
• Hindsight drives expectations
• Marquis management and/or famous investors
• Appears cheap using management’s metric
• Accounting issues 

For me, the idea of a unique metric that only applies to one company has always been fascinating, especially since so many analysts fall for it over and over again. “Management sets up their own metrics and they become well-accepted,” Chanos said last night. While this isn’t always a clear-cut sign of fraud, it should, as an investor, at least cause you to ask questions, instead of buying a management’s line hook, line and sinker.

In talking about value traps, Chanos singled out several stocks that he thinks meets that definition for various reasons. Among those are Consol Energy (CNX), Petrobras (PBR), Hewlett-Packard(HPQ), Coinstar (CSTR), Banco Santander (SAN), and Australian-based Fortescue (FMG).Another rule that Chanos said he always emphasizes to his graduate students at Yale Business School (the class is called Financial Fraud: A Historical Perspective) on the very first day of class is that the financial statements are prepared by the company — not independent auditors who (this is over simplifying it a bit) really only sign off on what they’ve been provided with and thus, don’t even know what might be missing.

He also said that some of his best short ideas arise from when assets become liabilities, noting that Best Buy (BBW) is “increasingly becoming the showroom for Amazon (AMZN).”